Q3. Suppose you are evaluating an investment opportunity in an office building for which you have estimated the following financial characteristics:

• First year net operating income (NOI) = $75,000.
• Growth rate in net operating income = 5% per year.
• Tax depreciation = $10,000 per year.
• Annual interest expense = $9,000.
• Annual total debt service expense = $12,000.
• Equity investors marginal income tax rate = 36%.
• Investment horizon = four years.

The cash flows after taxes for years one and four are closest to:

A)   CFAT₁ = $42,840 and CFAT₄ = $50,406.

B)   CFAT₁ = $51,480 and CFAT₄ = $50,766.

C)   CFAT = $42,840 and CFAT₄ = $47,760.

Q4. property was purchased for $550,000 and sold after six years for $850,000. Costs associated with the sale were $65,000 and the tax depreciation in each year was $20,000. At the time of the sale, $320,000 remained outstanding on the mortgage. The tax rate on recaptured depreciation is 28% and the long-term capital gains tax rate is 20%. The equity reversion after taxes for this property is closest to:

A)   $384,400.

B)   $365,600.

C)   $449,400.

Q3. Suppose you are evaluating an investment opportunity in an office building for which you have estimated the following financial characteristics: fficeffice" />

• First year net operating income (NOI) = $75,000.
• Growth rate in net operating income = 5% per year.
• Tax depreciation = $10,000 per year.
• Annual interest expense = $9,000.
• Annual total debt service expense = $12,000.
• Equity investors marginal income tax rate = 36%.
• Investment horizon = four years.

The cash flows after taxes for years one and four are closest to:

A)   CFAT₁ = $42,840 and CFAT₄ = $50,406.

B)   CFAT₁ = $51,480 and CFAT₄ = $50,766.

C)   CFAT = $42,840 and CFAT₄ = $47,760.

Correct answer is A)

Taxes Payable Computation:
	Year-1	Year-2	Year-3	Year-4
NOI (g = 5%)	$75,000	$78,750	$82,688	$86,822
Less depreciation	(10,000)	(10,000)	(10,000)	(10,000)
Less interest	(9,000)	(9,000)	(9,000)	(9,000)
Taxable income	$56,000	$59,750	$63,688	$67,822
times tax rate	′0.36	′0.36	′0.36	′0.36
Income taxes payable	$20,160	$21,510	$22,928	$24,416
CFATt Computation:
	Year-1	Year-2	Year-3	Year-3
NOI (g = 5%)	$75,000	$78,750	$82,688	$86,822
Less debt service	(12,000)	(12,000)	(12,000)	(12,000)
Before tax cash flow	$63,000	$66,750	$70,688	$74,822
Less taxes payable	(20,160)	(21,510)	(22,928)	(24,416)
CFAT	$42,840	$45,240	$47,760	$50,406

Q4. property was purchased for $550,000 and sold after six years for $850,000. Costs associated with the sale were $65,000 and the tax depreciation in each year was $20,000. At the time of the sale, $320,000 remained outstanding on the mortgage. The tax rate on recaptured depreciation is 28% and the long-term capital gains tax rate is 20%. The equity reversion after taxes for this property is closest to:

A)   $384,400.

B)   $365,600.

C)   $449,400.

Correct answer is A)

Equity reversion after taxes (ERAT) = net selling price – mortgage balance – taxes.

First, compute taxes.

Recaptured depreciation = 6 × $20,000 = $120,000

Tax on recaptured depreciation = $120,000 ′ 0.28 = $33,600

Total gain on sale = net selling price – adjusted basis

Net selling price = sales price – cost of sale= $850,000 - 65,000 = $785,000

Adjusted basis = cost - accumulated depreciation = $550,000 - 120,000 = $430,000

Total gain = $785,000 - 430,000 = $355,000.

long-term capital gains tax

= capital gains tax rate × (total gain - recaptured depreciation) = 0.20 × (355,000 – 120,000) = 0.20 × 235,000 = $47,000

Total taxes payable

= tax on recaptured depreciation + tax on long-term capital gains = $33,600 + $47,000 = $80,600

ERAT = net selling price – mortgage balance – taxes = 785,000 - 320,000 - 80,600 = $384,400